The Pre-Judgment Agreement
Most pre-judgment agreements that attempt to resolve litigation without the consent of the liability insurance carrier involve three components: (1) an assignment of the insured's rights against its liability insurer to the injured party; (2) the injured party's agreement not to execute against the insured's assets; and (3) a judgment establishing the insured's liability and the injured party's damages. Insurers have attacked each of these components in challenging pre-judgment agreements, though the legal architecture of the agreements has been validated by the majority of courts.
A. The Assignment.
While pre-judgment agreements come in many different shapes and sizes, they share in common the assignment of the insured's rights to the injured party. In some instances, the insured may agree to prosecute a lawsuit against the insurer and to assign the proceeds, if any, collected in the action to the injured party. In other cases, the parties may agree that the injured party will prosecute the lawsuit in the insured's name pursuant to an assignment of rights.
Most courts that have considered the issue have concluded that assignments of this nature are permissible, though some have held that the insured may only assign the right to collect the judgment, and not personal claims for emotional distress and punitive damages. In Colorado, it is permissible for an insured, following entry of an excess judgment in a contested trial, to agree to prosecute an action against its liability insurer and to assign to the injured party the proceeds, if any, recovered in the action in order to satisfy the judgment. Further, in Olmstead v. Allstate Ins. Co., the U.S. District Court for the District of Colorado concluded that a cause of action for failure to settle may be assigned directly to the injured party for prosecution following the entry of judgment.
Logically, if the proceeds collected in an action brought by the insured against its carrier may be assigned, it would also seem that the insured is allowed to assign its claim against the insurer directly to the injured party. Indeed, as noted in Olmstead, this is the prevailing majority rule. In a similar vein, because it is permissible for an insured to assign its rights against its insurer to the injured party, it should not matter whether the assignment technically takes place before or after the entry of judgment. It is axiomatic that principles of contract law, and, in particular, the law of assignments, apply equally to all contracts, regardless of when they are made. Moreover, pre-judgment agreements can, and usually do, provide for the assignment to take place after the judgment enters, which would seem to obviate any technical problem that a court might have with the timing of the assignment.
B. The Covenant Not To Execute.
Pre-judgment agreements also share in common a promise by the injured party not to execute against the insured's personal assets. Insurers challenging pre-judgment agreements have argued that the covenant not to execute relieves the insured of liability, with the result that the insurer has no obligation to indemnify the insured under the terms of the policy. In effect, this argument is an attempt by the insurer to benefit from the insured's bargain with the injured party, despite the fact that the agreement was negotiated not to confer a benefit on the insurer, but rather, to hold it responsible for allegedly unreasonable conduct. As a stranger to the agreement, the insurer should not be allowed to benefit from its terms.
Indeed, the overwhelming majority of jurisdictions, including Colorado in the post-judgment context, recognize that a covenant not to execute is not a release that extinguishes the insured's liability to the injured party; it is merely a promise, the breach of which may give rise to a claim for damages as between the parties to the agreement (i.e., the insured and the injured party). While the Colorado Supreme Court has not addressed the significance of a covenant not to execute in the pre-judgment context, there is no reason that it should have a different effect than in a post-judgment agreement, as principles of contract law should apply equally to all contracts regardless of when made. Because a covenant not to execute does not extinguish the insured's liability when entered into after a judgment, it follows that it should not be deemed to do so when made prior to the entry of judgment.
In addition to arguing that a covenant not to execute releases the insured of liability, insurers have also asserted that an insured who is protected by a covenant not to execute can suffer no damages, as a matter of law, because it will never be required to pay the judgment. As the argument goes, because the insured will never have to pay the judgment, the insurer should not be required to indemnify either the insured or the insured's assignee. In support of this no damages argument, insurers often cite the so-called payment rule, which dictates that an insurer may be held liable for a judgment in excess of policy limits only if the insured has paid part or all of the judgment. The rationale underlying this rule is that where an insured does not pay any money in satisfaction of an excess judgment, the insured is not harmed and thus may not collect damages.
While a few courts have adopted the payment rule, the overwhelming majority of jurisdictions have rejected it. Courts in these latter jurisdictions instead follow the judgment rule, which recognizes that the entry of judgment . . . alone is sufficient damages for an insured to sustain a recovery from an insurer for its breach of duty. They have found significant the fact that the insurance policies in question insured against liability, not reimbursement. Thus, these courts have concluded that the insured's actual payment of an excess judgment, and its ability to pay the excess judgment, are irrelevant considerations when examining whether the insurer may be held responsible to pay the judgment. Indeed, the Colorado Supreme Court embraced this principle in both the Bashor and Trimble decisions.
The rationale behind allowing full recovery to an insured who has not paid the excess judgment is to prevent bad-faith practices in the insurance industry by eliminating the insurer's ability to hide behind the financial status of its insured. It has also been noted that the judgment rule prevents an insurer from benefiting from the poverty of an insured who has a meritorious claim but cannot first pay the judgment imposed upon him. If payment or demonstration of ability to pay a judgment were the rule, then an insurer would be encouraged to refuse to settle a claim merely because the insured is insolvent, which would impair the use of insurance by the poor. In adopting the judgment rule in a case involving an excess judgment entered against an insolvent estate, the Tenth Circuit explained:
Where, as here, the decedent tortfeasor had no funds, the insurer who failed to settle should not be allowed to successfully assert that it is not liable despite its breach of duty because the decedent tortfeasor was without funds. Such a rule would encourage the insurer to avoid its duty in many cases. It would balance the risk in every case knowing that it had an escape hatch. Refusal to settle within the policy limits would be the rule.
Such a course would impair the use of insurance for a poor man. The fullness or the emptiness of an insured's purse should be irrelevant. It is a poor measure of liability by the insurer under its contract.
The fact is that courts permitting pre-judgment agreements coupled with covenants not to execute do so because it is thought that an insured that has been placed at economic risk by its insurer's breach should be allowed to protect itself by shifting the risk to the breaching insurer without first subjecting itself to potential financial ruin. Given that the covenant not to execute is a centerpiece of any pre- or post-judgment agreement, allowing insurers to use the covenant to argue that the insured has sustained no damages would deprive the insured of the only means it may have to protect itself when its insurance carrier has acted improperly. A blanket prohibition on the use of pre-judgment agreements containing covenants not to execute would result in more cases going to trial with resulting economic hardship to insured's; an injured party would be loathe to enter into such an agreement if the covenant not to execute precluded its enforcement, while an insured would have little incentive to enter into the agreement if it did not contain a covenant protecting the insured's assets. Thus, assuming the judgment is not the product of fraud or collusion, discussed below, the use of a covenant not to execute in a pre-judgment agreement provides no basis on which to hold the agreement unenforceable.